Living annuities and tax

Article By: Jillian Kipling (acsis financial planning coach)

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Question:
I understand the proposed taxation on lump sum withdrawals (0 percent up to R300 000, 18 percent up to R600 000, etc) on early (forced) retirement, but can you please clarify taxation tables on the further monthly withdrawals (e.g. max 17.5 percent) from a living annuity (bought with the balance of the original ex-pension funds)?

Answer:
The balance left in the annuity fund (after one has taken up to one third as a lump sum) is what is used to pay out a monthly pension for as long as that remaining money lasts.

In a perfect situation the capital amount held in the living annuity vehicle generates enough income to pay out a pension (of between 2.5 percent and 17.5 percent of the capital per current regulations) without eating into the original capital, and in an even better scenario, actually adding to it to cater for inflation.

If the investment is generating a net return of 12 percent and you are only withdrawing a 10 percent pension, then this is an example of that ideal situation as your capital amount will be increased by the leftover income. However if you are drawing out 17.5 percent then your capital will start to erode, affecting your pension income too, as a smaller capital amount will produce a smaller payout even on a fixed percentage withdrawal.

It has been argued that the capital being withdrawn in such an instance should not be taxed as it is not income. The general ruling, however, is that certain other tax advantages have been allowed, so any annuity paid out is subject to income tax at the marginal rate.

The tax advantages of a living annuity are:

Contributions to the original pension fund were tax deductible.

Any investment returns on funds held within the annuity vehicle are not taxed, which can have a huge impact on growing those funds.

Transfer of the funds from the pension to a living annuity is tax free.

What this means is that in a living annuity with a capital amount of R2-million, at a drawdown of 10 percent, the monthly 'pension' will be R16 666 per month. This is taxed according to the income tax tables (currently between 25 percent and 30 percent on this income level).

The retirement tax reforms are still under way and it is expected that in future the tax concessions will be increasingly more favourable. People won?t be penalised for, but rather encouraged to save for retirement. Watch this space!

acsis Limited is an authorised financial services provider. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a financial planner who, after an analysis of the individuals? personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice.